‘Co-opetition’ among funds pays

It may seem like a hidden truth but asset owners are in competition with one another.

They are in competition for the best alpha ideas, the best manager products and the best research – all with the aim of improving risk-return trade-offs to increase the likelihood of meeting their liabilities.

As a result, many asset owners find it difficult to collaborate, even on initiatives that may prove mutually beneficial.

At the Thinking Ahead Institute’s recent Sydney roundtable, asset owners highlighted the top three barriers to successful collaboration with peers: difficulties being transparent; lack of time and resources; and difficulties aligning interests. At the same time, however, attendees agreed on the value to funds of collaborating on industry structure, regulation, and a universal agenda for alignment of owners’ interests.

The word ‘co-opetition’ was described in Adam Brandenburger and Barry Nalebuff’s 1997 book of that name and refers to the ability of competing businesses to co-operate for mutually beneficial outcomes. The authors took insights directly from game theory, which also applies to the myriad investment decisions pension fund boards need to make in efforts to fulfil the requirements of several potentially misaligned stakeholders.

The pursuit of rational but non-collaborative strategies generally produces poorer outcomes (prisoners’ dilemma) whereas better payoffs can often be produced through effective methods of collaboration or government influence.

Proof in the research

There are numerous academic articles and research projects that prove this assertion. Here are three examples:

Inefficient pricing: The race to outperform one another (largely but not exclusively through listed equities), often forces asset managers to rely heavily on momentum and other non-information-based strategies. This causes mispricing away from fundamental values, leading to sub-optimal capital allocation, which lowers long-term returns.

Agency costs: The growth of intermediaries and other agents has led to increased complexity and uncertainty, and substantial increases in costs. And given that active management is, in effect, a negative-sum game after fees, aggregate returns are reduced.

Excessive choice: Bird and Gray refer to Joshua Fear and Geraldine Pace’s 2009 article “Australia’s ‘choice of fund’ legislation: success or failure?” in arguing that despite the plethora of investment strategies available, a large portion of Australian institutional retirement savings funds are essentially identical, with little investment choice exercised. Therefore, members bear the direct and indirect costs of competition-induced excessive choice. Additionally, the average fund size was seen to be well below that needed to benefit from economies of scale including lower fees. (There is a trade-off involved here, between economies of scale enjoyed by larger funds, and the ability of smaller funds to express conviction and flexibly alter their positions. Better outcomes would have been achieved with better default design for workers who ‘choose not to choose’.

Bird and Gray suggest that these leakages can be plugged by rationalising the retirement savings industry and its agents and through greater co-operation (such as through joint research efforts) while retaining the genuine benefits of productive competition.

In universal owners’ interest

Willis Towers Watson’s Roger Urwin, in his 2011 paper “Pension funds as universal owners: opportunity beckons and leadership calls”, argues that it’s in the interest of universal owners, which through their portfolios own a slice of the whole economy and the market, to collaborate with other asset owners to ensure the health of the investment ecosystem as a whole. In a nutshell, while universal owners adapt their actions to try to directly enhance the value of their portfolios, they indirectly help the whole economy secure a more prosperous and sustainable future.

Finally, in its survey this year of 15 best-practice asset owners carried out on behalf of the Future Fund, Willis Towers Watson observed the following trends:

Some participants have developed more strategic partnerships and have seen benefits in sharing information in areas such as operations, human resources and technology. All participants agreed that peer collaboration had proved valuable to some extent, but noted that further work needed to be done to crystallise these opportunities.

The participants were cognisant of their external profiles, and greater success was aligned with where their profiles had been deliberately and carefully cultivated, often through proactive and highly visible strategies. Willis Towers Watson noted that there were growing expectations of leading asset owners to exercise positive influences in pursuit of their financial goals in co-operation with others, and to consider environmental, social and governance issues through their ownership interests. Peer relationships and collaborations are particularly helpful in this regard.

Many participants outlined explicit goals to enhance collaboration, whilst some described instances of co-investment success, although most saw this as more limited in reality than they had initially hoped. Several are now looking to be more discerning and targeted in their collaboration activities, aiming to make one or two relationships much richer and deeper. The limits to senior time and bandwidth are clear constraints.

Effective collaboration without sacrificing the genuine benefits of competition requires clearly defined objectives and goals. It also requires a mindset shift among asset owners that recognises these strategic partnerships have the potential to be mutually beneficial.

Marisa Hall is senior investment consultant in the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.